CONSOL Energy: Great Company, But Fully Valued?

CONSOL Energy (NYSE: CNX) has largely silenced long-term critics, of which there were many. Back in 2010-11 when the company was making significant inroads into natural gas, culminated with a multi-billion dollar acquisition of shale assets, critics were not shy to speak out. Within months, CONSOL's move looked like a loser, not because it was not well conceived, but simply because natural gas prices fell out of bed in 2012. However, with natural gas prices now comfortably back above $4 per MCF (from under $2 for several months in 2012), the company's strategy looks a lot smarter, and the stock price has moved up substantially, approaching a double off its 52-week low.

With this year's disposal of a meaningful portion of the company's coal operations, CONSOL is now largely a natural gas business. However, it retains some very solid coal assets, including a premium low-vol coking coal mine and it has built a strong conventional and unconventional natural gas portfolio. CONSOL had an analyst day earlier in June in which it laid out its plans for its shale gas properties for 2014 and beyond. Again, a strong portfolio with good prospects. However, I believe the current share price fully reflects the strength of this segment.

Pure-play coal players fall by the wayside....Until about a year ago, CONSOL used to be compared to coal companies like Alpha Natural Resources, (NYSE: ANR) , Peabody Energy (NYSE: BTU) , Walter Energy (NYSE: WLT) , and Arch Coal (NYSE: ACI) . No longer is that the case. CONSOL is up 65% over the past year. Among the former peers, only Peabody is up, just 12%, while Walter is down 51%, Alpha is down 31%, and Arch is down 7%. Of course, this is not surprising given that natural gas prices have doubled over the past 12-18 months while thermal coal prices are flat to down and coking coal prices are at seven-year lows.

Alpha, Peabody, Walter, and Arch had opportunities to diversify their heavy coal exposures or at least to take measured bets. Instead, they made debt-funded acquisitions at the top of the market. Alpha bought troubled Massey Energy, Peabody acquired Macarthur Coal in Australia, Arch took out East Coast player International Coal and Walter merged with Canada's Western Coal. Each and every single deal was fueled with a large component of debt. At the time, coking coal prices were at or above $300 per metric tonne. Today the benchmark price is 64% lower at $120 per tonne. Considering that coking coal price decline, perhaps nothing more needs to be said...

Still, these coal players could have moved into natural gas like CONSOL did. They could have acquired some safer coal infrastructure assets like CONSOL did, (CONSOL owns a coal port facility in Baltimore). But most importantly, they could have avoided paying through the nose for additional coal assets just before the bottom fell out of the market!

CONSOL's shale assets looking good, but is this growing segment enough to move the stock?At the analyst day, the company demonstrated strong and improving operating metrics with IRRs ranging from 18% to 57%. Compare that to the 20% IRRs of typical mining projects -- and that's for good mining projects. Management believes that IRRs will continue to improve to the 40%-100% range over time. As good as these metrics are, CONSOL has an enterprise value of $14 billion and the shale assets are still relatively small. As a result, the company's EV/EBITDA ratio is pretty high at about 15x for 2014. To be fair, this ratio will fall in 2015 and 2016, but investors risk declining natural gas prices between now and then.

Bottom lineCONSOL has done a superb job diversifying from coal and shareholders have been rewarded with CONSOL stock up 65% in the past year. However, without a significant increase in natural gas prices, it's difficult to get too excited about the company's prospects over the next year, only because of the scale of those assets compared to a $14 billion enterprise value.

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